Aug 062012

Tennessee Court of Appeals: Unlicensed Contractors and the Importance of Contract Review

The Devil is in the details. In Friday’s opinion of Anchor Pipe Company, Inc. v. Sweeney-Bronze Development, LLC et al., the Tennessee Court of Appeals reviewed the priority of two liens, a mechanic’s lien and a bank’s deed of trust, filed in connection with development of the Enoch Hill subdivision in Gallatin, Tennessee. The Circuit Court for Sumner County awarded summary judgment to the bank and granted it priority over the mechanic’s liens. The Court of Appeals disagreed.

The Court of Appeals first addressed whether a contractor who contracts for work above the monetary limit applicable to his license is an “unlicensed contractor” for purposes of the Contractors Licensing Act of 1994, Tenn. Code Ann. § 62-6-101 et seq. This act requires persons or entities performing activities defined as “contracting” to have a license, and makes it unlawful for a person or entity to engage in contracting without a license. Tenn. Code Ann. §§ 62-6-101, 62-6-103(a). An unlicensed contractor is only permitted to recover actual documented expenses upon a showing of clear and convincing proof.

Traditionally, a contractor is unlicensed for purposes of Tenn. Code Ann. § 62-6-103(b) if the contractor does not maintain a valid contractor’s license throughout the entire time contracting services are performed under the contract. Kyle v. Williams, 98 S.W.3d 661, 666 (Tenn. 2003). In the present case, the contractor had a contractor’s license throughout its work on the project and this license authorized it to perform the type of work it performed (underground piping, grading and drainage, and base and paving work). However, the monetary limit on the contractor’s license was only $750,000, whereas its bids exceeded two million dollars. Thus, the bank argued that the contractor was unlicensed because it bid on and performed work in excess of the limits of its license. The Court of Appeals disagreed and drew a distinction between contractors who are completely unlicensed and those who have complied with the licensing laws and may in some manner violate the provisions or limitations of their licenses.

Even if the Court had found that the contractor was unlicensed, outside the context of single-family residential construction, the fact that a contractor is unlicensed does not result in forfeiture of the contractor’s lien in Tennessee. See Tenn. Code Ann. § 62-6-128.

The final issues reviewed by the Court of Appeals touched on the importance proper document review and execution.

In the first avoidable error, the developer failed to properly establish a subordination agreement with the contractor. While working on the bank loan, the developer asked the contractor via e-mail if it would subordinate its lien to the bank’s lien rights. In its response, the contractor stated it would sign a release. However, a release was never finalized. An agreement to agree to something in the future is generally not enforceable. Thus, the e-mails alone were not sufficient to establish a contract and the contractor’s lien was never properly subordinated to the bank’s lien rights.

In the second avoidable error, the bank identified the wrong grantor of the bank’s deed of trust meaning the deed was void and the bank did not properly perfect its security interest. Although the identified grantor was a wholly owned subsidiary of the parent company (the correct grantor to the bank’s deed of trust), there was nothing in the record to suggest that the identified grantor had acted on behalf of the parent company in executing the bank’s deed of trust. When an agent fails to reveal his status, he alone is bound as principal. The bank later corrected this error and identified the correct grantor but only after the contractor’s date of visible commencement of operations had occurred. Thus, the contractor’s lien once again took priority over the bank’s lien rights.

Jul 302012

Construction Loan Agreements: Unless Agreed To, Lender Has No Duty To Protect Borrower’s Interests

The risk involved with a construction loan makes it very unattractive for most lenders. Nonetheless, commercial banks are drawn to construction loans because it allows them to maintain their liquidity. When the provisions of a construction loan agreement are negotiated, the bank will traditionally request monitoring systems for the disbursed funds to minimize the risk it assumes with the loan.

The general rule in Tennessee is that, in the absence of a contrary agreement between the parties, a lender owes no duty to a borrower to disburse the loan proceeds for the borrower’s benefit. This means that a lender has no affirmative duty to protect the borrower’s interests. However, as an exception to this rule the lender may assume such a duty by agreement.

In Suzich v. Booker, et al. (affirmed on Friday, July 27, 2012), a $1.7 million construction loan was exhausted prior to the completion of the borrowers’ residence. As a result, a contractor filed his claim for a materialmen’s lien for $95,000 and subsequently sued the borrowers and the lender, First Citizens National Bank, to enforce same. The borrowers responded with a cross complaint against the lender alleging that the lender breached the construction loan agreement when it disbursed all of the loan funds without inspecting the progress of the construction. The lender responded that it did not have a contractual duty to inspect the construction of the residence.

After reviewing the provisions of the construction loan agreement, the Court of Appeals agreed with the lender. In looking at the entire contract, the Court reasoned that while the lender was entitled to demand an inspection before disbursing funds to the borrowers, it was “not obligated to inspect . . . or inform [the borrowers] about the Project’s progress or performance.” Thus, the construction loan agreement did not explicitly require the lender to assume an affirmative duty to protect the borrowers’ interests.

The decision of the Court hinged on its interpretation of several provisions of the construction loan agreement. This is why all of the provisions in a construction loan agreement are important to both lender’s counsel and borrower’s counsel.